Donald Trump, the U.S. president-elect, has long nursed well-known grievances about the European Union. He has pointed to the large bilateral trade deficit between the United States and the EU—about $131 billion in 2022 and $208 billion in 2023—as proof that the Europeans are not playing by the rules and are taking advantage of American naiveté. To address the rest of the world’s “unfair” trade practices, he has promised to impose tariffs of at least ten percent on all imports, including those coming from major European trading partners. Trump has also called into question whether the United States should continue to guarantee Europe’s security through NATO, and he laments the military and financial aid that Congress has provided to Ukraine for its defense against Russian aggression. Together with his vice-president-elect, JD Vance, Trump believes that Europeans should supply the lion’s share of future aid for Ukraine, so that the United States can shift its attention to China and the Pacific.

There is an ongoing debate in Europe about how best to handle the incoming Trump administration. Some argue that Trump should be, in effect, bought off. Christine Lagarde, the president of the European Central Bank, has suggested that Europe needs to use a “checkbook strategy” and offer to “buy certain things from the United States.” European Commission President Ursula von der Leyen has observed that the EU still gets too much of its liquefied natural gas—nearly 20 percent—from Russia and that it would be better to buy more from the United States. EU officials are also considering buying more U.S. defense equipment to induce Trump to drop his new demand that NATO allies spend three or even five percent of GDP on defense. But there are other EU officials who doubt that Trump will forgo tariffs against Europe in return for a few symbolic “buy American” gestures. They believe Europe must prepare for tit-for-tat retaliation and threaten to put an equivalent ten percent tariff on all U.S. imports.

The problem with all these short-term strategies is that they fail to address the EU’s longer-term structural problems. A change in trade policy is not the answer. The EU’s trade surplus with the United States was $20.5 billion in October 2024, up from just under $17.5 billion the same month a year prior. This trade balance is just a part of the EU’s current account surplus with the rest of the world, which increased from $64.4 billion in the second quarter of 2023 to $134.4 billion in the second quarter of 2024. That current account balance is the mirror image of the EU’s own imbalance between its domestic savings and domestic investment. Europeans lack neither savings nor opportunities for investment. What they lack is the ability to move money efficiently from one part of the EU to the next. National rules regarding income taxation, pension funds, risk absorption, and bankruptcy proceedings make it unattractive for investors to look beyond the boundaries of their own countries to the rest of Europe. As a result, much of Europe’s savings either sits idle in domestic banks or chases higher returns in the deeper, more liquid capital markets in the United States. Buying more U.S. weapons or liquefied natural gas is not going to solve that problem or address the continent’s security vulnerabilities.

Europeans must make long-term investments in industry, including for defense. To that end, some of the best answers to Trump’s provocations can be found in two major reports published last year. In April, the Council of the European Union released a report, prepared by former Italian Prime Minister Enrico Letta, on reforming the single market. In September, the European Commission published another report, by former Italian Prime Minister Mario Draghi, on enhancing EU competitiveness. Both reports argue that Europe’s relative economic decline constitutes an existential threat to the European Union and stress the importance of strengthening research, innovation, and sustained investments in new technologies to reverse that decline. And both explain that the only way the EU will achieve these goals is by making it easier and more attractive for Europeans to invest their savings within the EU, rather than burrowing them in savings accounts or investing them abroad.

If European leaders find the political will to implement the reports’ recommendations, the EU will be home to a single market that can punch at its true weight in the international arena; it will become stronger and more self-sufficient. Should Europeans fail to act in unison to realize this vision, they will lose jobs, investment, and innovation to the United States and China, at the cost of ever-lower standards of living.

TOWARD A MORE PERFECT UNION

Keeping more European savings in Europe, rather than exporting them abroad, will go a long way toward rebalancing the continent’s economy and will help reduce its trade surplus with the United States. To that end, Letta has proposed the creation of a savings and investment union, which would make it easier for governments to channel state aid into strategic priorities such as renewable energy, artificial intelligence, and military technology. Both Letta and Draghi also insist that unlocking domestic savings is a crucial step in creating a true common market for the defense industry; most defense financing and procurement currently happens at the member-state level.

But many challenges lie ahead. European governments do not work together easily on matters related to income taxation. They do not like their private pension funds to take on what they see as unnecessary risks. They do not have confidence in the financial literacy of their own citizens and maintain strict regulations that disincentivize potentially risky investing. They are reluctant to lose control over bankruptcy proceedings, particularly when that might result in the liquidation of family-owned assets. All these wrinkles and much else will have to be ironed out before Europeans can create what EU leaders are now increasingly referring to as a “capital markets union,” an initiative to create a single capital market that has been discussed since at least the 1990s.

Draghi talks about competitiveness as an “existential challenge” for the EU and estimates that Europeans will need to invest an additional 800 billion euros a year (about $820 billion) to restore the continent’s industrial prowess. He argues that European governments must use nonmarket instruments such as credit guarantees, subsidies, and tax incentives to point private investors in the right direction. Funding such schemes would require a substantial increase in borrowing. Some of that borrowing would have to be done by the EU acting collectively, as happened during the pandemic in 2020. Such collective borrowing would be particularly important for European defense. Draghi laments the fragmented state of the continent’s defense industrial sector, stressing the need for scale and demand aggregation. His report calls for an increase in direct EU defense funding and the creation of a common defense industry authority to make procurements on behalf of member states.

Another round of collective European borrowing is politically controversial but would pay real dividends in smoothing transatlantic relations. Right now, Trump looks at the EU as a strategic competitor and prefers to negotiate directly with European governments rather than with the EU as an entity. When it comes to trade and current account imbalances, he will have to deal directly with the EU, but as long as the EU lacks integration in security and defense, he can play EU member states against one another. Implementing the recommendations of the Letta and Draghi reports would help reassure Europeans and their allies that the EU is serious about providing for its own military and economic security. Continuing to rely solely on procurement from the United States is incompatible with Europe’s longer-term security autonomy; such dependence is no longer a realistic option.

LEADERSHIP VOID

The successful implementation of the Letta and Draghi reports would change the nature of European integration both economically and politically. In the past, major progress on the European project has been led by the EU’s two largest founding member states, France and Germany. That Franco-German leadership is hard to imagine today as both countries face domestic political uncertainties. In November 2024, German Chancellor Olaf Scholz saw his coalition of Social Democrats, Greens, and liberals fall apart over the issue of new debt. With elections due to be held on February 23, and with lengthy coalition talks likely to follow, Berlin will be unable to push forward any significant reforms over the next few months. In France, President Emmanuel Macron remains in office but not in power, as he struggles to form a stable government and avoid a fresh vote of no confidence. Political clarity will probably not return to France until the summer of 2025, the earliest that new legislative elections can be held.

It is possible that various new “coalitions of the willing” could emerge. If the incoming Trump administration cuts or reduces military and financial assistance to Ukraine, a coalition led by, say, Poland could bankroll the Ukrainian resistance to Russia’s aggression but would still struggle to fully compensate for any substantial loss of U.S. funding. Such a coalition might include France, the Netherlands, and the Baltic and Scandinavian countries; it would also surely receive financial and military support from the United Kingdom. But in other arenas, including international trade, the European Commission and the European Council (the bodies that make up the executive of the EU), rather than any individual member state, will have to fill the leadership void.

The good news is that EU institutions are in a relatively strong position when viewed against the backdrop of the ongoing political turmoil in member states. After a successful first term at the European Commission, von der Leyen is starting her second term with experience and a clear mandate. The commission also benefits from the appointment of Kaja Kallas, the former prime minister of Estonia, to the post of high representative for foreign affairs and security policy. The press frequently refers to her as “Europe’s new Iron Lady.” She is a staunch defender of Ukrainian sovereignty and is under no illusions when it comes to dealing with either Trump or Russian President Vladimir Putin. Finally, the election of former Portuguese Prime Minister António Costa, a compassionate and pragmatic social democrat with a reputation for consensus building, to lead the European Council promises to bring a more cooperative atmosphere to the body.

But despite these positive developments, the EU is not as cohesive a political entity as the United States. For Europeans to implement the Letta and Draghi recommendations, it will be necessary for EU member states to line up alongside EU institutions. At a minimum, political leaders at the national level should not get in the way.

UNDER PRESSURE

The political obstacles to fulfilling the Letta and Draghi agendas are significant. Europe needs its 27 member states to unite and think big, including on bringing Ukraine and countries in the western Balkans into the fold. But many of the leaders that are ideologically close to Trump—such as Hungarian Prime Minister Viktor Orban, Slovakian Prime Minister Robert Fico, and Italian Prime Minister Giorgia Meloni—are also the most Euroskeptic and reluctant to transfer more of their sovereign powers to Brussels. Poor growth prospects for 2025 do not help. Economic stagnation is expected to continue in Germany, and the outlook for France and Italy is not much better. As most European governments were forced to submit austerity budgets for 2025, the eurozone is unlikely to gain any more fiscal space that would allow increases in public spending or lower taxes that could boost aggregate demand. Finding new money will require creative thinking and new tweaks to the fiscal rules.

Some EU member states will likely look to make bilateral deals with the incoming Trump administration rather than work through the EU. Hungary and Slovakia have governments that are more sympathetic to Moscow than to Kyiv and have welcomed Trump’s promised plans to bring peace, even if that peace comes at the expense of Ukraine’s territorial integrity and lacks ironclad security guarantees. Orban has been a thorn in the side of the EU over the past decade when it comes to support for Ukraine and upholding democratic principles and the rule of law. In both Italy and the Netherlands, two founding EU members, the far right is currently in power and shares Trump’s anti-immigration posture and broader right-wing agenda. Meloni has been a staunch supporter of Ukraine, but her coalition partners are less than enthusiastic. In the Netherlands, Geert Wilders, the leader of the largest political party in government, the far-right Party for Freedom, may be tempted to support Washington’s efforts to pressure Kyiv into making unpalatable concessions to Moscow.

Such divisions extend into the Franco-German core of the EU. In Germany, Friedrich Merz, the leader of the Christian Democratic Union, looks set to become chancellor when the country votes in February, assuming his party’s large lead in the opinion polls holds. Merz is decidedly pro-EU, but he does not support collective borrowing at the European level and is even doubtful about more domestic borrowing. He is probably willing to adjust Germany’s constitutional debt brake to allow for additional spending on defense, but that is only a minor concession given the scale of public investment the country needs. In France, new legislative elections could take place next summer to break the current impasse, and the far-right National Rally party of Marine Le Pen and Jordan Bardella may well be able to win an outright majority. Should they prevail, Macron would be even less effective in his efforts to push through his vision of a strategically autonomous Europe.

It is possible that external pressure will help forge a strong European Union. The return of Trump to the White House next week will mark the end of the U.S.-led rules-based international order in which free markets reigned and the United States’ security guarantee for Europe could be taken for granted. A more transactional U.S. foreign policy may force the EU to adapt and finally exploit its own economic strength and build out its own defense capabilities, resulting in a stronger and more cohesive Europe. Or Trump’s sharp-elbowed diplomacy may drive a wedge between EU member states. The incoming U.S. president hopes to see Europe diminished as a strategic competitor, but this outcome would not be in the longer-term economic or security interests of Europe, or even of the United States, as the Europeans remain the United States’ most reliable and steadfast democratic allies in a volatile and dangerous world. The EU can avoid division and marginalization by embracing the Letta and Draghi agendas.

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